Investment and Debt Capacity

Stock Repurchase Repurchase of stress skunk be viewed in individually of the following counseling givement, backing, sh beholder distri exception and pick up issue. Repurchase of stock can be a way to use theatres excess debt capacity. By doing so, unattackable can deject the embody of equity financing. If debt financing is to a greater extent flexible and cheap, replace equity financing with debt financing is a good way to lower the weighted equal of cr stimulate. In this sense, such feat is a financing issue because it controls the embody of financing. On the other hand, repurchase of stock can prepare shareholder distribution.If shareholders consist of most individual investors, they whitethorn require more dividends or other forms of kale sharing. Firm can repurchase stocks from such investors so that they can adjust their dividend policy. If management holds few shares of the company, they whitethorn lose their control over depart and dodging decisions. By re purchasing stocks, management could regain majority control over the company on strategic decisions. Finally, repurchase of stock is withal an coronation issue because it enables the firm to increase its return on equity by eliminating dilution effect.Higher return on equity will realise more favorable investors as well as better vendors. It has the same outcome of investing in businesses, so it can be viewed as an investment. Debt Capacity for Stock Repurchase From Exhibit 5, we get the bestow debt of Marriott at the end of 1979. We define fare debt as sum of short-term loan, menstruum portion of long-term debt, senior debt and capital leases. The average market bell of Marriott in 1979 was $14. 9, and matter to rate for Baa somatic debt was 12%. We assume that Marriott would repurchase stocks at wrong of $15 using 12% debt financing.Marriott used correct EBIT over net interest as a cadence for debt capacity, so we use such measure as well. The table above shows the ma in assumptions we make in the analysis. Before the stock repurchase, EBIT adjusted/ final interest rate was 6. 64, above the 5 times threshold Marriott set for itself. Because the net interest sooner repurchase was $27. 8 million, we stop that adjusted EBIT was $184. 59 million. In 1979, additional debt from repurchase was $159 million, making the total debt $538. 83 million. Net interest after repurchase is the original net interest plus the 12% interest from new debt.Based on such analysis, the new adjusted EBIT/Net interest ratio is 3. 94, which is lower than 5. So we conclude Marriott may not have enough debt capacity to finance the stock repurchase. We push perform a scenario analysis. Suppose Marriott had just enough debt capacity, which means new adjusted EBIT/Net interest ratio equals 5. We find that repurchase price should be $7. 17 so that Marriott could utilize its debt capacity fully. We conclude that a repurchase price under $7. 17 is in feature transferring value to remaining sort out because they can share more future profits resulting from the concentrated equity.Yet a repurchase of $15 is way above $7. 17, which means change shareholders have more value because they are compensated with high return. own vs Managed Marriot has cardinal options about the operation of hotel chains. First, it can own the hotel and enjoy the profit margin. Second, it can sell the hotel but retain management contracts so it controls the operation of such units. Following is the detailed decomposition of monetary values associated with two options. According to Exhibit 9, in 1978 the typical cost for a hotel room consists of improvement cost, furniture, fixtures and equipment cost, land cost, pre-opening cost and operating cost.For an own hotel, Marriot had to pay the total cost for running the property, but if it is managed, Marriot only had operating cost because the buyer was responsible for the maintenance. In an attempt to emphasize more on return on in vested capital rather than margins, Marriot sold some of their existing hotels and retained management contract to save up capital. Managed hotels had operating margin of 8%-10%, while owned had 15%. We assume 10% margin for managed hotels and 15% for owned hotels.To decide when to sell the property, we analyze the remaining present value of future cash flow of a hotel at different point of time in its life cycle. We further assume that when the hotel is sold, the selling price is set so that present value of future cash flow equals the 10% margin. We assume $50 r planeue per room night of a typical 150-room hotel, and one year has 360 days. Sales level for each year in the life cycle connects to the occupation rate. From the graph of Exhibit 9, we get different occupancy rate for the whole life cycle. It reaches the peak 100% at year 8, and after year 10, it declines most linearly to 10% in year 30.We can see that if Marriot sells the hotel ahead opening, the selling price wou ld be $1. 63 million at time 0. After the peak, lets say, year 9, the selling price would be $ 1. 55 million at time 9. We can also see that in fact the max value of PV is at year 4, which has $2. 85 million in PV at 15% margin. Marriot would free up more capital if it sells the hotel before opening, but instead it would lose more operating profit. If Marriot is in short of capital, it could sell the hotel up-front so that the freed up capital can be invested in other moneymaking projects.Selling after the peak is a good choice if Marriot wants to enjoy the increasing operating profit before the peak. Shareholder value can be added if the return on freed-up capital exceeds the profit loss from selling the property. Recommendation Based on our analysis, we would recommend the company to investing in their bosom business to fully use their debt capacity. Since Marriotts debt capacity is only able to repurchase 10. 6 million shares at a price significantly lower its current trading p rice (according to Exhibit 12). It is unlikely the repurchase strategy would take place as expected.The negative impact of false interpretation that the Marriott has reached its growth limit may not be offset steady if the repurchase take place. To decide whether to invest in core business or diversify by acquisition we take a look of the hotels current state. The company now is operating in four main sectors, hotel collection, contract food service, restaurant group theme parks and cruise ships& other. Based on exhibit 3, all of MCs sectors are doing well in the past few periods Hotel group is motionless the main profit sector narrative for 51% of the total operating profit and 16. % of the gross margin. Theme park and restaurant sectors have contributed a lot to total revenue but at the same time involve more risk. The asset associated with that new business couldnt be mortgaged easily. Marriotts theme park alone was estimated to cost 80 million but double of the estimation e ventually, the investment made MC to lower its debt character reference level. If we use the extra debt capacity on acquisition of new business, there could be a higher risk of availability and cost of long-term debt financing, which may cause MC to lower its debt credit even lower and increase its defalt risk.As a company mostly processioned in hotel management, invest in new businesses that needful new management style also increases MCs operating risk. Marriotts hotel business has positioned itself to operate for customers whose travel plans were less subject to change than those of vacationers. Its historical operation has showed steady healthy growth even in recessions. Most of the sectors assets are real estates and tends to appreciate over time rather than depreciate, it is easy to issue debt secured by hotel assets. Prevailing trends also indicate sighs of need of rapid room working out.As MCs major competitors Hilton and Holiday Inn are shifting their core business to a more diversified market, keep focus on core hotel business enable MC to maintain its own competitive advantage in operation. Overall we would suggest MC to use its excess debt capacity to invest in existing hotel with some clientele base but lower entry cost where the Marriotts acquisition can significantly improve the operation. To invest in such assets, there is low query and construction cost but easy to manage with sustainable growth. We believe that the best investment for tidy sum would be investing in the existing business.The hotel business was the most promising area for Marriotts Corporation. When MCs competitors expand their business into gambling and casino ventures, MC was more likely to expand in the traditional market. To invest in the hotel business, a vast amount of external financing is needed. A large amount of Marriott hotels were managed rather than owned by the MC. Despite the MC could limited capital investment by holding the equity up to 50% so that they c ould increase the opportunity to be awarded the management contract, they tycoon still need to cost a lot in investing more hotels. MC could also choose to expand their existing hotels.Those hotels have higher occupancy rate and higher local demand. Doing this expansion will need full capital investment in property. With high growth rate of hotel rooms, this investment seems valuable. However, this way of investment still needs large amount of external financing to support the expanding. counterbalance though MCs new hotels are profitable in the end, the cost of developing hotels is still required a big financing. In addition, due to the increasing inflation rate, the cost of equity and the cost of debt increased. Therefore, as inflation rate becomes higher, the unused debt capacity becomes less in the future.